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Is Microsoft Inc. Overpaying for LinkedIn?

Jeff Weiner, Satya Nadella, Reid Hoffman, left to right. Image source: Microsoft.

By now, you've probably heard Microsoft (NASDAQ: MSFT) is buying LinkedIn (NYSE: LNKD) for a staggering $26.2 billion.

In reaction to the news, LinkedIn stock soared over 40%, ending Monday's trading within pennies of the $192 per-share price agreed on by the two parties. However, Microsoft shares opened Monday's trading down roughly 4%, eventually settling down about 3% on the day.

Between the whopping dollar value attached to the deal and the market's divergent reaction, this raises an important question for Microsoft shareholders: Is Microsoft overpaying for LinkedIn?

LinkedIn should eventually mint money for Microsoft

On the surface, Microsoft's decision to buy LinkedIn makes sense in that it both helps further Microsoft's own corporate strategy and provides the tech giant with what should eventually mature into a lucrative stream of profits.

In terms of its likely financial payoff, LinkedIn should eventually grow into a sizable profit driver for Microsoft. On the way to eventual bottom-line profitability, LinkedIn's EBITDA is expected to surpass $1 billion for the first time ever this year. Per S&P Capital IQ estimates, the average of sell-side analyst projects LinkedIn's EBITDA to increase to $2.3 billion by the end of the decade, and $3.1 billion by 2022.

Assuming these estimates prove correct, they imply Microsoft will realize an eventual annual 11.8% pre-tax return on its $26.2 billion investment. What's more, LinkedIn's status as the lone professional social network means the company should enjoy meaningful network effects and a wide economic moat, which should protect its ability to throw off spare cash well into the future.

True, Microsoft could lose its triple-A credit rating as a result of the LinkedIn acquisition, but the interest rates at which it will borrow will still be low enough that it will all but virtually make the bet a financial windfall for Microsoft and its investors -- and that doesn't even take into account how Microsoft could also enhance its own profitability by leveraging LinkedIn's unique social networking and content capabilities.

Likely benefits for Microsoft

The specific ways Microsoft can tap into LinkedIn's products and data aren't entirely clear at this early stage, but many observers agree the software giant should be able to use LinkedIn to make more money from its own suite of products.

In reaction to the deal, a note from Bank of America Merrill Lynch's sell-side team mentioned potential integrations like LinkedIn's instructive videos into Microsoft's Help and Yammer business products. Several analysts also singled out Microsoft's Dynamics CRM product and Cortana voice-based assistant as potential beneficiaries of LinkedIn's social media big data set. Again, these suggested benefits remain noticeably devoid of specifics, but it appears Microsoft should be able to tap into LinkedIn's capabilities to further its own efforts in addition to the purported financial benefits discussed earlier.

It's worth noting that the deal faces some skeptics. For instance, renowned venture capitalist Roger McNamee criticized the deal in an interview with CNBC, saying, "It's really simple: Big deals don't work." Indeed, it bears noting that Microsoft has bungled several past multibillion-dollar acquisitions -- namely Nokia and aQuantitative, which resulted in respective writedowns of $7.6 billion in 2015 and $6.2 billion in 2012. That's a lot of shareholder value destroyed. However, it also bears noting that each deal took place prior to Satya Nadella's elevation to the CEO role.

Despite its relatively low cost of financing, this is indeed a major gamble on Microsoft's part. So, while it's potential revenue synergies aren't as clearly defined as investors might like, it seems Microsoft and LinkedIn products and strategies are complementary enough to add strategic and financial benefits for Microsoft shareholders.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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